In My Opinion:

How Big a Threat Is Offshoring?

by George F. McClure

High-tech job outsourcing has become a staple in more and more corporate business plans, with companies promising to perform Information Technology (IT) functions more efficiently offshore than they could if they performed the work themselves. Fifteen years ago, Charles Handy articulated the “shamrock organization,” which outsourced all non-core functions (1). Initially, business analysts viewed this concept as a domestic win-win, as jobs typically moved from one U.S. company to another. But more recently, companies have found that they can improve their bottom line further by taking advantage of lower labor costs offshore. This latest trend: offshore outsourcing.

Low Labor Costs, More Venture Capital

The dual attractions to offshoring are cheap labor cost and the availability of venture capital for foreign direct investment (FDI) in enterprises, plants and laboratories. More and more, Multinational Entities (MNEs) want to locate appropriate activities in countries that offer comparable advantages (2).

When David Ricardo described the “creative destruction” theory of business management, he was referring to inefficient, unprofitable firms giving way to more productive uses of the scarce resources of capital and labor to create more profits by bringing better products to market (3). Offshoring puts a new spin on the theory; it sidelines expensive domestic labor in favor of cheaper foreign labor (2) and diverts capital investment to lower-cost countries.

Reasons Firms Send Their Work Offshore

A number of considerations are driving companies to offshore business operations, not the least is the financial pressure from Wall Street and the board room to "keep up with the Jonses." Companies emphasize access to skilled workers and new markets as drivers for offshoring. Lower labor costs, greater venture capital availability and less stringent regulation make offshoring attractive to companies. These factors break down to:

• No health insurance premiums for employees

• No retirement benefit costs

• No payroll taxes (i.e., Social Security, Medicare)

• No unemployment compensation fund premiums (state, federal)

• No employment safeguards (overtime, discrimination)

• No health and safety standards

• No environmental restrictions

• No paid vacation days, holidays

• No severance pay

• No unions or collective bargaining

• No Sarbanes-Oxley attestations by management on accuracy of financial reporting

• Same or lower corporate taxes (except Germany, Italy)

India and China: Huge Offshoring Venues

According to a July 2003 report by Gartner, Inc., corporate spending for offshore IT services is projected to increase from $1.8 billion in 2003 to $26 billion in 2007. Work going to India will account for about half of the $26 billion. India has grown its call center, business process outsourcing and software business, while China has accepted FDI for establishing manufacturing plants and has maintained a favorable fixed currency relation with the U.S. dollar. In addition, both have welcomed the research and engineering facilities established by U.S. and multinational corporations.

Proponents of offshoring as a logical extension of free trade point out that sending lower-skill jobs elsewhere frees up the U.S. workforce to focus on higher-skill jobs. On the other hand, critics respond that the extent of offshoring, coupled with the collapse of dot-com industry, has resulted in more jobs lost in Silicon Valley than in the entire state of Ohio, which has suffered similarly from the transfer of manufacturing offshore. Since the dot-com collapse, venture capital has been more readily available for enterprises in India and China than in the United States (4).

The offshoring trend will not reverse itself. Even tax incentives to keep work in this country will not outweigh the savings gained by offshoring.

Of course, the United States is not the only country affected. European countries with high worker wages and benefits face competition from lower-wage eastern European countries. To keep their jobs from moving offshore, workers in a Robert Bosch plant in France agreed to work an additional hour per week without pay, after company officials told them they would move the company to the Czech Republic if productivity did not improve. In Germany, Siemens convinced a labor union to permit its members to work 40 hours for 35 hours’ pay, raising productivity rather than losing jobs.

The Grass Isn’t Always Greener

Many companies have learned that the surface attraction of offshoring is often not borne out by the bottom-line savings. Cultural differences come into play. In India, for example, workers will often do exactly what they are told to do without speaking up — even when they can see that another direction would produce better results. In addition, experience levels and infrastructure support are lower in other countries than for displaced U.S. workers, so overall, productivity is lower.

Can’t Work, Can’t Buy

Companies are feeling the backlash to offshoring in their revenue pockets. Critics note that even if the result is cheaper consumer goods, unemployed U.S. citizens do not have the financial resources to buy them. The lower-wage workers in India and China will not make up for the lost market demand. As one CIO Magazine reader wrote, “I am losing my job because of outsourcing. I make $18.00 an hour and they say China can do the same thing for less than a dollar an hour” (www.cio.com).

Governments Stepping In

State legislatures have taken notice of the effects of offshoring. In fact, legislatures in 35 states have draft legislation on the table to address offshoring. Many of the bills would ban government agencies from contracting with companies that plan to employ overseas workers on contracts. Those who criticize offshoring of taxpayer-funded work say it deprives capable American IT workers of jobs, while proponents say that because the work costs less offshore, offshoring saves tax dollars. In all, individual states and the federal government have proposed 161 state laws and more than 50 federal laws to restrict or ban offshoring (www.tiecon.org).

Various members of Congress have asked the Government Accountability Office (GAO) for data regarding the extent to which offshoring is eliminating American jobs. The GAO agreed in August to study the trend of U.S. companies exporting engineering and technical jobs to cheaper overseas labor markets. The study will look at this trend and analyze the impacts on technical and aerospace employees. It will also review the treatment of IT outsourcing in U.S. trade policy, and offer recommendations for enhancing U.S. competitiveness in the global marketplace (www.techsunite.org).

Offshoring and Next-Generation Workforce

In July, Rep. Frank Wolf (R-Va.) pushed for a $2 million grant from the Commerce Department’s Economic and Statistics Administration (ESA) for the National Academy of Public Administration to study the implications of offshoring on the science and technology workforce. Wolf said he is concerned not only about current job losses but also about the impact offshoring could have on present and future students studying technical fields critical to economic growth, such as engineering and computer science. The grant, included in ESA's FY2005 budget, will fund a study to collect data from business, education and government, as well as professional associations and employee organizations (www.house.gov/wolf/news).

Coming Up

IEEE-USA Today's Engineer will publish periodic articles to address issues associated with offshoring. In an upcoming issue, for example, we will look at concerns about the loss of data privacy and national security concerns that arise when software modifications to defense or homeland security systems are made offshore.

References

1. Charles Handy, The Age of Unreason, Boston: Harvard Business School Press, 1989, Chapter 4
    

2. Charles W. L. Hill, Global Business Today, New York: McGraw-Hill, 2000. See Chapter 4, International Trade Theory http://www.radford.edu/~aorlov/econ340/Ch04.pdf
    

3. David Ricardo, Principles of Political Economy and Taxation, 1817
    

4. “The Myth Behind China’s Miracle,” George J. Gilboy, Foreign Affairs, Volume 83, No. 4, July/August 2004
    

5. “Tech Job Upheaval,” InformationWeek, 02 August 2004
    

6. Charles Handy, Beyond Certainty: the Changing Worlds of Organizations, Boston: Harvard Business School Press, 1996; see Chapter Two — “The Coming Work Culture”
    

7. CIO Magazine ranked 24 candidate offshore countries for their attractiveness to do IT work, based on political stability, wage level and English-speaking ability. Many countries have programmers available for less than $12,000 per year. See CIO’s 2004 “World Tour” article at www.cio.com

George McClure is chair IEEE-USA's Communications Committee, a member of the IEEE-USA Career & Workforce Policy Committee, and technology policy editor for IEEE-USA Today’s Engineer. The opinions expressed in this article are the author's.